Don't ignore the housekeeping

A tax bill for investments left untouched for decades and money gifts to children leave a portfolio carrying risk

I live in a substantial property and would like to make gifts to my children. We have looked at home income plans but my children are not keen as it will deplete the value of my estate. So I want to see whether I can arrange to gift money to help them as one is in financial difficulties and the other wants to upgrade his property.

These were the questions I was asked by Dorothy, a widow in her late 70s with two children in their 40s. They are not dependent on her but have asked her to make gifts to them.

Dorothy lives in a substantial property. The house has been converted into a maisonette in which she lives and a flat which brings her rental. This, together with dividend income and her state pension, give her sufficient income for her requirements.

The part of her financial scenario that needs attention is some investments she inherited in the late 1970s. It always brings a shudder to a financial planner’s heart to see investments that have lain untouched for decades. There had been no capital gains tax allowances taken and no Isas bought. Thus, the point for considering capital gains, which is relevant to encashing parts of a portfolio in order to make gifts to her children, is March 31, 1982.

Despite the last decade’s volatile markets, it would have been very difficult to have chosen investments that did not grow since 1982. This is why Dorothy has gains that are significantly more than her CGT allowance.

My aim is to minimise Dorothy’s tax liability and make her investments more suitable for her. Currently, they are entirely unsuitable 100 per cent of her portfolio is in equities, with a significant percentage in individual shares.

Thankfully, gathering information about the capital gains on her shares was not the torrid, lengthy exercise that I had anticipated. Dorothy has been drawing the dividends from her shares annually and I was able to turn to her accountant for the calculations of what would take her to the threshold of higher-rate tax.

So although some CGT liability will be paid, we should minimise its impact.

I was very concerned about the amount of gift that Dorothy wanted to make to her children as it represents a quarter of her liquid investments.

Although this does not leave her without funds, at the age she is, she might need additional funds in the future such as for care. It is certain that making encashments at this level will reduce her dividend income, thus requiring further capital withdrawals to top up income.

There is no ideal solution in a case like this so everything is a compromise. The conclusion we reached is that the encashments should be made, and the 10 per cent tax liability should be effectively footed by her children by receiving smaller sums. This was accepted.

However, these gifts meant that we have been unable to shape up her portfolio, which means Dorothy is carrying unnecessary risk. But there is another tax year not too far away, so we will be able to use next year’s allowances to bring the investments more in line with her risk tolerance.

From now on, her capital gains allowance will be used and Isas will be bought from her investments.

Dorothy’s tax bill was unnecessary. If the simple housekeeping had been done, she would have been in a position where no tax would have been paid when encashing the portfolio.

I also felt strongly that her children should understand the impact of what their gift had on their mother’s portfolio. The letter I drafted for her was in such a form that it will be appropriate to give to her children to review. Certainly it will make planning Dorothy’s portfolio more difficult if we have unexpected demands from her children in the future.